Cummins Inc. (CMI) Earnings Call Transcript & Summary

Okay. Good afternoon, everyone. Welcome to this fireside chat with Cummins management. I'm really delighted to have with us Jenny Bush, President of Power Systems; and Chris Clulow, Vice President of Investor Relations. Jenny and Chris, thank you so much for joining us.

Thank you.

Thank you.

To frame the conversation, Chris, can we just start going back to the Analyst Day? You and the team outlined a path to 2 to 3 points of margin expansion by 2030. Excluding the Accelera investment drag, you're already at the low end of that range this year for the base business. So what's gone ahead of plan in terms of margin performance this year?

Yes. Yes, that's a really nice problem to have when you're kind of hitting your 2030 targets just 4 months after you announce them. But I think things have gone quite well across the business, and we'll, of course, talk about Jenny's piece of the business, which Power Systems has led the way in terms of margin improvement. But we've seen good performance in the Engine business, which we've been working on for a number of years. It's a heavy investment period, as you know, in Engine business, getting ready for EPA27. But we're seeing good baseline performance, good efficiency in the plants and really kind of coming through. Similar story in Components, and then Distribution has done quite well. So we're seeing good flow of parts and really good margin performance there. So I think there's really -- most everything is going a bit better than expectations with maybe the exception of China, which is about at expectations, which is flat. And then, yes, I'd be remiss to not give credit to Jenny, who's -- the Power Systems business has really been the star in terms of financial performance and operational as well.

Yes. And Jenny, on that note, you took over the business in 2022. Margins were 12%, with good returns because of high capital velocity, but now margins are approaching 20%. Data center has been nice, but it's not up that much. Can you talk to us about your strategy to running the business and how that's different versus what it has been in the past for the segment?

Yes. And I can -- I'm just mindful of my mic, so I want to make sure I get it. So let me tell you a little bit about the business first, just to kind of set the stage. So Power Systems is really the tale of 2 businesses. It's a large engine industrials business, think mining, think oil and gas, think marine, big units, heavy industrials. And then the power generation business is the only place in the company where we're the OEM. In most cases, we sell our products into somebody else's equipment. They go to market, and off we go. In power generation, we actually make the equipment itself. So we own the alternator manufacturing. We own that piece of equipment. The engine, of course, across the range, it's bigger than just the engines that I make. And my segment also goes all the way through the Engine business range. And then the radiators, we acquired a company at the beginning of this year to add into that space. So we own all of those things. Power Systems, as you said rightly, has been a challenging environment. And the change in Power Systems isn't just data center growth, it's a piece of it, but it's actually not the largest piece of what we've been doing. We've been working hard on standardization of products. We've been working hard on maximization of capacity and utilization, solving cost to price, those types of things, making sure we're getting value accretion in that area. In this piece of the business, we go to market in a couple of ways. We go direct into OEMs like Komatsu, like Hitachi, others like that, but then we also utilize our distribution channel. And so this is, particularly in data centers, has been a real win for us. Because when you sell a PowerGen piece of equipment, often, you're selling switch gear, you're selling fuel tanks, you're selling installation, operating elements of that business. And because we own our distribution channel, it allows us to capture value beyond just the equipment sale. And that is unique in our market. In power generation, those elements always exist. They're called the balance of plant, regardless of a data center or somewhere else. But because we own our channel, it gives us that opportunity to standardize that equipment, but also to gain the value and the long-term running of that equipment that nobody else in our market can do.

And Jenny, can we unpack the standardization point? So that's something that I would perceive would take a while to implement that type of strategy as the company have been working on that for a while. And so essentially, cost per unit coming down is what I'm hearing?

Yes. I mean power generation, particularly, is very project orientated. So the tendency over the years is to build the portfolio. And we've launched some new products in our Centum series that's extended the density of our engines. That has then allowed us to standardize much faster than it would be if we were just taking a very mature portfolio and downsizing what you were able to provide. Our newest product is the least standardized, no surprise, because we're able to fit that and tailor that better. So I gave an example earlier today. I walked into one of my inventory holding centers in the U.K. a couple of years ago, and you can look at pieces of inventory. And when it doesn't look the same, it's a little bit challenging. And so the proliferation at the component level that we've been working hard on to get that standardization, so launch of new products helps us accelerate that and then allows us to also solve it in the back side of the business as well in terms of making sure that we continue to reduce that through the portfolio.

And looking at the company's disclosures in the past prior to your tenure, it's been hard for this segment to pass through cost increases when they've accelerated. Can you talk about your approach to pricing?

Yes. We've spent a lot of time on value-based pricing. So we generally do okay in the sense of inflationary cost and price. The challenge in our business, rather, is because there's so much proliferation, it's really easy to lose sight of cost to price. By standardizing, by solving the way that you price and how you actually attribute value to your products, you can solve that equation. And so that's -- it kind of goes hand-in-hand with some of the other work that we've been doing to enable us to do that. So we've been able to make sure that when we tailor a product for a customer, which is super appropriate because not everything is the same, we're actually able to add value into the pricing of the equipment for that customer. And so that's been very helpful.

Got it. And so higher percent margins given the complexity?

Correct. Yes.

And in terms of looking at the competitor set, best-in-class margins are in the mid-20s. Is that feasible for your line of business?

I mean, I -- this -- my CEO would love me to get there. I'll just put that out there. Yes, I think it's possible. I think there's a lot of things that play into that in terms of being able to leverage volume. We're at a very great time at the moment in the sense that we're able to maximize our utilization of our plants. That helps us get the best leverage, which helps us then return much more accretion in the margin position. So yes, I mean, it's possible. I think it will take a while. It's not a flip -- a switch you can flip it. It's a lot more challenging than that, but definitely things we're working towards.

And to continue down the margin conversation for the broader company, Chris, you folks spoke about R&D normalizing at the Analyst Day. Can you just expand on that comment? Because normally, for you folks, given how technical the products are, sales grow, R&D grows, and it's all high-returns investment. And it sounds like there might be an opportunity for R&D-to-sales ratio to decline going forward? Is that the idea?

Yes, it is. It is. Because right now, we're in a really heavy investment mode, particularly in our Engine business because we're launching 3 new platforms. And just to give you a sense on the engine, when you're doing engines, you only do a platform investment every 25-plus years. And then you can tailor off that as you go through emission cycles. We're doing 3 new ones at the same time. It's very fortuitive timing because this can extend the life of an ICE engine for far, far longer, drives more efficiency at the right -- perfect time for the market. And so it's -- that takes more investment. When you're doing like a full-platform level of investment, it is a significantly more than you have -- when you do tailoring going on. So after we get through EPA27, that will come back down to more normalized levels, and you'll see that for the Engine business, as well as in the Components business, a more normal spend going forward. And we can just move off those platforms and kind of build that out. Because those are launching pre-EPA27, but those platforms will be used throughout the world as emissions change over time. So I think that is -- we're making the big investment, but we see, even in the most -- going back a couple of years when we made this decision, where we're getting pushed, where it's going battery electric in 10 years, and what's your future. We're getting those questions. Even in those scenarios, very attractive payoffs. Now that it's become evident it's going slower, very, very good payoffs in terms of the investments we're making. So I think we're seeing that. And then on the other side with Accelera, we're not seeing the same level of investment going forward as it's progressing a bit more slower.

And Chris, on that point, EPA27, I know it's the company's view that it gets implemented. In the scenario that if it doesn't get implemented, are we using these same platforms without the additional after treatment? And I appreciate that that's not the base case for you, but governments do what governments do.

Governments do what they do. But I mean, yes, our view is it does move forward from a technical perspective. Going to 0.035 NOx is the expectation. And EPA and CARB are aligned on that. I mean it does get complicated if EPA were to pull back on that. Does CARB move forward? And then you have half the country that goes one way and half goes the other, and then it becomes quite messy. But you can -- because we've redesigned these engines, it will take some work. It's not a matter of just use the current after treatment on a new system and you get to maybe not as low a NOx emission and a more efficient engine. It will take some work to get there, but we do have our existing product line. So if it got pushed out, we can continue to sell that.

The mix of existing products would be the way forward?

Yes. And then you'd probably tailor it. It might have a mid emissions launch with a more efficient engine.

Got it. And then as we've had the margin conversation, things are going really well in Power Systems. Chris, you mentioned things are going well in Engines, and we're talking about R&D to sales declining off of current levels. Are there any parts of -- from a margin standpoint, that are headwinds over the next couple of years that kept you folks from setting more aggressive margin targets?

Yes. It's -- I mean, we talked a bit about Accelera and driving that towards breakeven. That's -- it's challenging. And I think we want to make sure we're doing the right thing. Our goal is to be breakeven by 2027. And -- but also doing the right strategic thing for the company in the long term. So we'll balance that out as we progress. So that will take some volume, particularly in battery electric. We're seeing, actually, for us, the market moving quite well. We're picking up more share in what is a smaller market because there's less competition. But I think we're seeing good progress there. In the other spaces, I think it's -- I don't think there's any particular headwinds. As we looked at our strategy and what we laid out in the Analyst Day for 2030, it wasn't dependent on, oh, we have to do this acquisition or just has to break in regulation or this -- it's execution within the company. So it's largely within our control, so nothing, in terms of a major headwind on that improvement, other than us executing and delivering.

Jenny, can we talk about data centers? So 2023, $1.4 billion in sales, $700 million Power Systems, $700 million in Distribution. How much is that business up in '24?

I mean, in '24, we've probably gained about 30% in terms of that kind of range for '24, and then it will continue to grow as we see '25, '26 and onwards. We're selling into '27 right now in this particular range. Our data center products go from a 50 liter, which is about 1.5 megawatts, all the way through to like 4, 4.5 megawatts of power per unit in terms of how we do that. And so depending on where you are in the world, depends on which variant of those things that you take and then, of course, extending our product range in our Centum launches that we started at the beginning of this year is helping us. Because as some product lines fill, others then become available. And as a result, we've been able to maximize our position in that growth in the market.

Very interesting. And maybe this goes to that point for power generation. You folks disclosed in the third quarter, revenue per unit accelerated by 40%. So it sounds like we're seeing the mix shift as you're delivering on that capacity?

Yes, definitely seeing some mix shift that's helping us in that space, and also allowing us to really make sure that we're maximizing where we build things. Because we build our engines and our generators in multiple places around the world, depending on the market they go to, if you can imagine, they're quite big products. And so really, you want to be in the market that you're in to be able to deliver those products to market. And different places in the world are accelerating in different rates.

And in terms of the growth that you're seeing this year, is it global or concentrated in the U.S.?

We've seen a big push in the U.S. for sure. I mean a lot of the big hyperscalers have a U.S. base, but they apply those products across the world. So we'll see pretty significant growth in Asia and pretty significant growth in Europe as well. Some of the more developing economies tend to go with smaller-footprint, data center-type applications, not necessarily the big global hyperscalers like the Microsofts, the Amazons, the Googles of the world. They're very different in terms of how they operate, but we've seen that growth across the piece. And I think we'll continue to see that growth accelerate, too, particularly in the Asia market. Malaysia, Singapore, I think that kind of area is becoming a pretty hot place to be in data centers.

And on the truck engine side, you folks have outstanding market share in Asia. Is it the same in Power Systems?

Yes. I mean it's kind of what you'd expect. The way that you should think about data centers is that owning the engine is the unlock for you to be able to be in that market. And so those companies that own the engines, they're like us. You know who they are. Those are the people that are in the market with us, and you'd expect similar share splits in between those ranges. And it really is down to who has that capability. If I'm buying your engine, for example, a Generac would be a good example there, where they buy both the engine, the alternate and the technology and pull it together, they're at the mercy of somebody else having capacity in large engines. And large engine capacity is a multiyear build-out if you're adding that to be able to then accelerate. So it's not a quick win to be able to go and just set up on large data centers. It really doesn't exist because of those factors.

And in terms of the performance for the business, for the Distribution segment, to your point, Jenny, you drive really good performance. PowerGen sales for Distribution were up 80% year-over-year. I know [ this quarter ], up 24%.

Yes. Distribution gets a little lumpy. So the challenge with Distribution is because I'm the supplier to Distribution. They get what I'm able to deliver. We've had significant amount of supply chain issues over the past couple of years in the large generator space. It's a super fragmented supply base in terms of people that are able to supply components into your engine factories and your power generation factories. Electronics have been a source of challenge in the truck business. That's true also in power generation and Power Systems in large industrials. And so what happens is, it kind of gets to be like a pig in the python in the sense that, if we have challenges, then distribution can't deliver either because we really don't stock inventory on these large pieces of equipment. We really want to -- we make to buy, so to speak, in terms of getting that throughput through the entire company. And so that's what you see a little bit in Distribution is some of that lumpiness is as a result of our planning and how we're able to deliver from our factories.

At times, it will come to like the commissioning of a data center as well. So they'll do the installation, do the upfit, and they do the commissioning, so there's a deferred revenue piece. So that adds to the lumpiness, to Jenny's point.

Yes.

Got it. And so the growth really accelerated this quarter. So it sounds like Distribution might have been under shipping demand through the...

Well, I was under delivering. I think if you're in Distribution, you think I'm under delivering, which is fine. I think the reality is we've been able to break lose some supply chain challenges over the past 6 to 12 months, and that's really helped us unlock throughput. And throughput has been a big piece of the margin creation story in Power Systems in terms of how we've been able to deliver that.

Well done. And so can you talk about how you folks have been able to do that? Because for large engines, large gensets or supply chain is pretty tight. How have you folks been able to do something like that?

Yes. I mean, we tend to focus in particular areas of the technology. We have something called 5 Cs, which are the core components of the engine. And then we have critical components in the generation. The fact that we have -- we own our alternator business is a real advantage for us here because it's allowed us to add capacity, and then to enable that capacity to then flow into power generation plants, where we put the engine and the alternator together to then go through and sell into the market. And so by focusing on particular components where we had real bottleneck and challenges, fuel systems was another one, we've been able to get that lift and to be able to solve that throughput issue.

And how much alternator capacity have you added?

Well, we've added capacity in India, China and Romania, which is actually where we build our largest alternators. We reduced capacity in the U.K. about 12 months ago, more because the market was changing. And then we've had a plant in Romania for a very long time. I think we've added like 10% to 15% of capacity in that plant. And then we've added new capacity in India and China. And we have a couple of alternator plants in both of those countries and continents to then enable a wider range of portfolio. And that's been helping that piece of the business as much as it's been helping Power Systems. And that rolls into my business in Power Systems.

And for alternator capacity, you've mentioned overall a plan to double your capacity for data center gensets. These alternator moves, are we all set in alternators to double overall production?

Yes, I mean, pretty much, it's all in line. So this is the benefit of having a vertically integrated product that we can actually control the investment to where we need it rather than being reliant on somebody else to make it for us. And so I think we're pretty on plan. In fact, we're probably ahead of plan in some cases on the move-up of our capacity, both in the U.S. and outside the U.S. for the -- particularly in the data center market.

Yes. And when we talked about the doubling capacity, that's at our 95-liter engine, the biggest engine that we offer, and that's the 3.5, 4-megawatt gensets that it supports. So we're working our way there. I think we were 30% of the way there by the end of this year, and we'll get there by the end of next year and doubling. That still doesn't put us at capacity in assembly. So we can continue to -- if the market continues to grow and expand, we still have some powder left.

And Chris, you and I have spoken about there are times when Cummins has acquired component manufacturers when they weren't able to scale up quickly enough. Jenny, are you thinking about the best range...

Yes, we just actually did that with our radiator -- we bought a radiator company at the beginning of the year, predominantly to protect the supply and then also to scale it faster. And we're demonstrating that right now and into '25 and '26 because it's a key component. That is a particular piece of the supply chain that's been very challenging in terms of access to suppliers that actually do that work. Those are very, very large units. You'd kind of be like the size of the screen behind me in terms of the size of the radiator. So they're pretty, pretty big. And so there's not many companies in the world that do those things. And so we acquired one of those in the beginning of this year, and that's been -- that's turned out to be a really good move, and we've been able to grow that. We're actually adding new plant in that environment as well. We'll add a facility there next year to make sure that we can capitalize on this growth.

And any other components like that? Or does this address what you need?

I mean, I think, they're the big ones because we already have the alternators. I mean if you just think about PowerGen engine, alternator, radiator, then you're into controls and skids and things like that. There's really not a lot of value creation in those extra areas that we feel like it's necessary to enable us to unlock the demand that we have.

And Jenny, at the Analyst Day, you folks outlined a plan for market share for data center, roughly 50% increase in your market share 2030 versus '26. Can you talk about what gives you that confidence?

Yes. I think that's because we've extended the power range. So I mentioned these products that we've launched, Centum. It's allowed us to push more technology and capacity into the data center market than we would have previously enjoyed. So traditionally, we would have gone after the 95 would have been really the only product in the data center space. So by up-powering, I can't kind of get the words out, we've spoken a lot today. By expanding the power range of our 78-liter, our 60-liter and our 50-liter products, actually, we've done that on a 17-liter, too, it allows us to actually fill more of the available space in the market than we would have traditionally enjoyed. So we feel -- that's why we feel confident about that because we've now got more products in the data center space that allows us to then capture share.

Very interesting. And in terms of the mix of business, just putting the pieces together. So third quarter, we spoke about high mix of high-ASP product. Given the work that you've done to address supply chain challenges, it sounds like we should expect that momentum to continue in terms of more production of higher-ASP units?

Yes. We don't see our business slowing down. We see it continuing on. We -- as I said, we're selling into '27 now, and the expansions that we've been putting in, in our plant, for example, in Seymour, Indiana, do serve broader market portfolio than just data centers. It's a piece of the puzzle, it's not all of it. And we're seeing pretty good stabilization in those other markets, growth in data centers, of course, which allows us to feel confident about where we are.

And then in terms of making engines available for industrial engines versus PowerGen, given the strong demand, how do you think about that? How do you make that decision?

I mean it's a great question. My industrial engine guy would tell me I don't give him enough, and of course, we'd like to do that. It's a balance, right? With all things, we need to make sure that we continue to play in the markets in which we're strong. Mining is a great example. It's a very strong place for us to be. We've partnered heavily with Komatsu in this area. So we can't allow ourselves to put all of that product just into data centers because we need to make sure that our mining business continues to be strong. And that is something that we are very focused on doing. And so in lots of cases, we really make sure that we try to be as fair as we can. We're selling out in terms of the orders, but at the same time, making sure that we've got enough capacity for our large industrial players, like Komatsu, for example.

Okay. And looking at the results in the third quarter, the average revenue per unit for industrial engines was up 10% year-over-year, too. Are you selling smaller engines anywhere? How much of that is price versus mix?

Yes. It's heavily mixed, for sure. I think it kind of skews the numbers just a little bit. We make products from 17 liters all the way up. Our highest-volume engines are in the smaller ranges, actually. In terms of our 19-liter engine, it's coming also out of our Seymour, Indiana plant, and that's also going pretty well. And so I think we've seen a pretty good balance across the piece. And so I think that's much more mix, that skew on the 10% versus pure volume in that respect.

And Chris, can we shift gears and just double-click on your Accelera comments earlier? So this dynamic of a slower adoption path for EV has generally been positive for Cummins. I'm wondering, in terms of the implications for the Accelera investment path, probably no burning need to invest as aggressively in R&D as we probably would have thought 6 to 12 months ago?

Yes, I think that's fair. I mean, we've looked at -- like I'll take an example, hydrogen space. So like fuel cells, that's something where we've kind of brought our investment down and keeping it warm. But that -- because it's pushed off into the right, like it's a decade plus out before it's really any wide-scale adoption of that. So I think we have like -- we'll take that down, and I think that's the question mark ahead of us as we're looking at the electrolyzer market. We have a wide range of outcomes because there is a lot of uncertainty in the space, and we'll adjust accordingly in that space. Battery electric is a little bit more clear for us. I think -- and that's why we have a narrower range as we look to 2030. And as I mentioned, the competitive landscape there has narrowed considerably. Pure plays, of course, have mostly gone by the wayside, and the OEMs aren't rushing to get in. So we are -- we can continue to do well in that space. We have more equipment in battery electric and commercial vehicle than anybody else in North America. So we can continue to build on that leadership position, and the margin is improving. So we're seeing -- track our gross margin really closely, and it's -- we're seeing that improvement and seeing a long way path to profitability. And it can play into the battery or electric space, also plays into ability to do hybrids and different things like that can help improve efficiency in our engines in the long term.

Right. And so for the electrolyzer point, the company made a well-timed acquisition to give you folks the capability. You've invested some CapEx. But as you mentioned, the outlook for demand and profitability for the industry probably is less attractive than also what we would have thought 6 to 12 months ago. How core are electrolyzers from a common standpoint?

Yes. I think -- actually, when we did the acquisition, they weren't even thought of. And we bought Hydrogenics a couple of years ago, and it was a fuel cell play, as we saw that, and then it came with this electrolyzer business. So it was kind of the gravy on top. And so -- and we continue to see it. It does have good potential in the long run. And it's moving well in a few spaces. It's moving fine in Europe. It's moving well in Canada. U.S. has become much more uncertain. It was already uncertain with some of the IRS ruling that we still don't have clarity on. And I think it's still going to be in that space so what we're going to do is just toggle the investment. We think there is a good potential for this in the medium to long term, and we'll keep -- kind of keep it going along. But I think that's where you can just toggle your investment. You toggle your capacity investment as well. And so this is not a big capital need, and it's not a huge R&D draw there, so we'll just -- I think, just have to monitor it closely.

Got it. Okay. And in terms of the battery plant, what's the path to profitability there? You made a really interesting point that, with the lower volumes, that plays to your advantage. Are you seeing folks coming in, having conversations with you that you would have thought would have built their own batteries in the plants?

Yes. Yes, I think that has definitely been the case, where, I think, we've seen nothing that we can announce. We let our customers do any announcing. But I think we are seeing more opportunity because early on, everybody went with the, what, the start-up because they came in with very attractive, if not attainable, sales contracts and so forth. But I think now it's like what is reality? And so they can see that our product delivers what they want. On the battery plant itself, it's expected to start production in '27, '28. That is a for-profit plant. So that will be a profitable joint venture. It also lowers our cost of the batteries and gives us more certainty on cost. That's the key element in battery electric in the long run is having some level of control over the battery cost. And it's got a lot of play there. So I think that's still looking like a good investment for the long term, and we'll just pace it out as the market matures.

Got it. Yes. And can we talk about tariffs? I assume the company has generally local for local, but there are some shipments across country lines. In a scenario where we do have adverse tariff developments, should we be able to count on Cummins passing that through to the customer?

Largely, yes. I think the whole industry, after going through -- going back 6, 7 years, it took us some time to pass those tariffs through. It took like renegotiation in the contracts and so forth. And many and most of our contracts now, it's already built in. So tariffs come. And if there's a negative outcome, it passes through pretty quickly. So I think there -- I think it will flow through the system rather quickly. So there is -- to your point, there are some spaces where, as an example, China, where there's no other sources. And it's not Tier 1 suppliers, but it might be Tier 3, 4 down the line. So yes, I think there's -- it will flow through rather quickly this time.

Last question, Components. Really, you folks have not only picked up content, but you've gained share on new regulations in the past. Based on the platforms that you're on, are you gaining share beyond content on EPA27?

Yes. For EPA27, I think it's a similar share in terms of where we served before, where we sell to some of the OEMs after treatments or turbos or so forth. We did pick up some share in the light-duty space, where we're doing after treatments, beginning next year for Stellantis. So we have picked up some business on that side. But I think it's largely -- we've maintained it, and the content will expand.

Super. Well, that's all the time we have. Chris, Jenny, thank you so much for joining us, and I appreciate the conversation.

Thank you. Thanks, everyone.

Thank you.